Chinese inflation goes global

Commentary: New China price, as we all pay for wage hikes

HONG KONG (MarketWatch) — Inflation has become a growing concern for mainland Chinese authorities and is now set to become everyone’s, as higher-priced made-in-China goods are exported around the globe.

Last week, Hong-Kong-based logistics and consumer-good sourcing company Li & Fung (494)
LFUGF, -2.33%
warned that we are now entering a new age, where sourcing in China will come with higher prices. The company, which is one of the largest suppliers of Chinese goods for Western retailers, described in a release that due to China, “the world has basically been in a low-supply-cost era for the last 30 years. The change in wage policy in China in 2009 — and the subsequent significant higher export prices — brings this status quo to an end.”

It added that increased product cost “seems inevitable.” What is more uncertain is whether consumers around the world will be willing to pay higher prices for goods, and how this will impact corporate margins and the global manufacturing landscape. It always seemed inevitable there would come a time when mainland workers would tire of working for pocket change to keep the West flush with an endless supply of cheap consumer products.

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Rising mainland wages has been in focus since Foxconn (2038)
FXCNF, +6.78%
hiked wages in response to worker suicides last year. A new survey last week from Standard Chartered Bank of its clients in China said they expect wages to increase between 9% and 15% this year, which is less than some reports, although it said labor shortages are also widespread.

It added that this is policy-driven, as the central government wants to raise minimum wages despite broader worries over inflation. But it also reflects the market dynamics as firms struggle to find workers. Standard Chartered’s survey found that 45% of firms were finding it harder to recruit workers this year, despite generally paying more than the minimum wage. The firms surveyed pay 1,800 to 2,000 yuan ($270-$300) a month, which is already 30%-40% above the minimum wage.

The response of firms surveyed has been to move production inland, rather than leave China itself, and increase the use of capital equipment to boost productivity.

This comes at a time when there is a widening appreciation that, this time, inflation in China is not transitory, caused by bad harvests or the like. There is a new China price.

Economists at Bank of America Merrill Lynch describe it as “the new normal for a new decade.” Put simply, they say consumer-price-index inflation will be elevated at around 4% in the coming years on the steadily rising cost of labor in China as it passes the Lewis Turning Point — that is, the point at which a developing country sees wages begin to rise quickly as surplus of labor from the countryside tapers off.

As this is digested, it will have various implications for investors. For many years, buying what China is buying, and selling any company that is making the same product as China, has been an investment theme. Whole industries have been outsourced, as China effectively hollowed out the industrial base from the U.S., Europe and the rest of Asia, with its gigantic manufacturing machine primed on cheap labor. Meanwhile, demand from China’s army of factories sent the price of everything from steel to coal to copper soaring.

While China’s labor is still relatively cheap, it is no longer the global cost leader. Given China’s size, it is going to be difficult to find anyone else to take its place. This means the era of China being a source of deflation in global markets and easy productivity gains for many companies looks to be over.

One investment theme getting more attention to play this transition is manufacturers of machinery and robotics, as China seeks to move up the value chain. Another area worth taking a closer look at will be industries that no longer face the same level of price competition from China. This could give a few more countries the chance to compete with China.

Li & Fung are in the fortunate position that they take a commission on all their trading business, so higher prices tend to be good for them. But many others margins will be squeezed unless companies can pass these rising prices on to the consumer.

On a wider perspective, China will now move from being a source of deflation to a global exporter of inflation. That is unlikely to be accepted by China’s leadership, who have recently complained the U.S. has been stoking inflation with the Fed’s quantitative easing. The end game may well come when these higher prices arrive in the U.S. and will force the Fed’s hand to begin tightening. Then everyone will end up paying for higher wages for China’s factory workers.

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